Chart of Accounts: Accuracy Vs. Comparability

Feb 17, 2016

I recently met with a business owner who is having issues determining his cash flow. He is worried if he pays a payable for $8,000 will he end up $8,000 short the following weeks payroll. He does not have a lot of comfort or tools to aid in his decision making. I offered the idea of a cash flow model which could help relieve some of his concerns. Typically, a cash flow model is an Excel spreadsheet built specifically to a client’s needs. It can function as a budget or a tool to aid in cash flow and overall business decisions. In this case, I suggested we would use the model as a budget and cash flow aid.

This client has several divisions within the business and in order to track each, he has created separate accounts. He admitted needing additional accounts to track each division, as a result he is constantly changing his chart of accounts. In fact, just as I began creating the model, he asked me to hold off change while he modified the chart of accounts. In my opinion, the use of separate accounts for each division is not nearly as useful as other alternatives. Instead, it proves to be difficult and time-consuming to run an income statement detailing specific accounts. Such a process would involve creating several filters, or manipulating data in Excel. If he was to utilize classes or another identifiable method for each category, he could run an income statement by class. This would only require a few clicks. To me, this would be more valuable as you could then determine your profit margin and net profit by category.

In addition, I advise against constantly change your chart of accounts because you lose comparability. If you are constantly changing the way you record an income or expense item, you no longer have the ability observe trends over a period of time. Older accounts no longer in use will have old information and a new account will only have the most current. Consistency in account usage allows for comparisons which aid in business decision making.

I am not advocating never making modifications to your chart of accounts or never considering other methods for accounting for items. If what you are currently doing is not functions, then it is certainly time to consider a review. Take your time to set up an efficient system to avoid possible issues in the future. Furthermore, accurate overhead allocations and correctly classified direct and indirect expenses are critical to your success. However, that is a blog topic in its own right!

Do you modify your chart of accounts frequently? Have you considered what it may look like if you did not? What kinds of decisions can you now make that you could not before?

Categories: Cost Accounting

Tax Responsibilities of An Estate Executor

Feb 16, 2016

Serving as the executor (“personal representative”) of someone’s estate can be a difficult job. Just identifying all the estate’s assets can be time consuming. Then there may be life insurance and employee benefit claims to file, appraisals to arrange for, property to manage, debts to collect, and final bills to pay. On top of everything, there are tax-related responsibilities an executor must address.

Decedent’s final return. An executor is responsible for filing the decedent’s final federal income-tax return covering the period from January 1 through the date of death.* Generally, a joint return may be filed with the decedent’s surviving spouse, but that’s not always the best choice. For example, more medical expenses may be deductible if a separate return is filed.

Estate assignment Estate’s income-tax return. An estate often receives income (interest, dividends, etc.) from the decedent’s holdings while the estate is being administered. A federal income-tax return must be filed for an estate in any year its gross income is $600 or more or if any beneficiary is a nonresident alien.* Whether to use a calendar or fiscal year for tax reporting purposes is one of the important decisions an executor has to make.

Estate-tax return. A federal estate-tax return is required if the value of the decedent’s gross estate at death (minus certain lifetime gifts) is more than the basic exclusion amount ($5.45 million for 2016).* An executor has several tax choices to make if a return is required. For example, it’s possible to value the estate on an “alternate valuation date” instead of the date of death. With fluctuating asset values, choosing the best date for estate valuation could be important in minimizing taxes.

The tax decisions an executor makes can affect what’s left for distribution to the estate’s beneficiaries. That’s all the more reason to consult a tax professional if you’re ever called upon to serve as an executor.

  • A smaller estate also may require a return in order to transfer any unused exclusion amount to the decedent’s surviving spouse.

Categories: Other Resources

Reasonable Compensation: Planning Ahead Can Save You Money

Feb 12, 2016

As the owner of an incorporated business, you’re probably aware there is a tax advantage to taking money out of the corporation as compensation (salary and bonus) rather than as dividends. The reason is simple. A corporation can deduct the compensation it pays, but not dividend payments. Thus, if funds are withdrawn as dividends, they are  taxed twice; once to the corporation and once to the recipient. Money paid out as compensation is taxed only once; to the employee in which it was received.

However, there is a limit on how much money you can take out of the corporation in this way. The law says compensation can be deducted only to the extent which is reasonable. Any unreasonable portion is nondeductible and, if paid to a shareholder, may be taxed as if it were a dividend. As a practical matter, the IRS rarely raises the issue of unreasonable compensation unless the payments are made to someone “related” to the corporation, such as a shareholder or a member of a shareholder’s family.

Fianance_Money12How much compensation is “reasonable”? There is no simple formula. The IRS attempts to determine an amount similar companies would pay for comparable services under like circumstances. Factors taken into consideration include:

  • employee’s duties;
  • amount of time required to perform those duties;
  • employee’s abilities and accomplishments;
  • complexity of the business
  • gross and net income of the business;
  • employee’s compensation history

There are a several steps you can take to make your compensation earned to be considered “reasonable”. For example, you can:

  • Use the minutes of the corporation’s board of directors to document the reasons for the amount of compensation paid
  • Keep compensation in line with what similar businesses are paying their executives
  • Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This is may be perceived as a disguised dividend, and will probably be treated as such by the IRS.
  • If the business is profitable, be sure to pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

Planning ahead and properly documenting your reasons can avoid problems down the road.

By: Jenny Furey, CPA

Categories: Other Resources

What Is Reasonable Compensation?

Feb 12, 2016

As the owner of an incorporated business, you’re probably aware there is a tax advantage to taking money out of the corporation as compensation (salary and bonus) rather than as dividends. The reason is simple. A corporation can deduct the compensation it pays, but not dividend payments. Thus, if funds are withdrawn as dividends, they are  taxed twice; once to the corporation and once to the recipient. Money paid out as compensation is taxed only once; to the employee in which it was received.

However, there is a limit on how much money you can take out of the corporation in this way. The law says compensation can be deducted only to the extent which is reasonable. Any unreasonable portion is nondeductible and, if paid to a shareholder, may be taxed as if it were a dividend. As a practical matter, the IRS rarely raises the issue of unreasonable compensation unless the payments are made to someone “related” to the corporation, such as a shareholder or a member of a shareholder’s family.

Finance_Money10How much compensation is “reasonable”? There is no simple formula. The IRS attempts to determine an amount similar companies would pay for comparable services under like circumstances. Factors taken into consideration include:

  • employee’s duties;
  • amount of time required to perform those duties;
  • employee’s abilities and accomplishments;
  • complexity of the business
  • gross and net income of the business;
  • employee’s compensation history

There are a several steps you can take to make your compensation earned to be considered “reasonable”. For example, you can:

  • Use the minutes of the corporation’s board of directors to document the reasons for the amount of compensation paid
  • Keep compensation in line with what similar businesses are paying their executives
  • Avoid paying compensation in direct proportion to the stock owned by the corporation’s shareholders. This is may be perceived as a disguised dividend, and will probably be treated as such by the IRS.
  • If the business is profitable, be sure to pay at least some dividends. This avoids giving the impression that the corporation is trying to pay out all of its profits as compensation.

Planning ahead and properly documenting your reasons can avoid problems down the road.

Categories: Healthcare & Dentistry

Outdated Cost System Impacting Profitability

Feb 11, 2016

A few weeks ago, I met with a potential new client regarding a costing matter related to their manufacturing company. The company had been in business for number of years and was profitable, but not nearly to the extent the owner perceived possible. He believed the costing system being used was providing inaccurate information and could be significantly improved upon for both costing information and overall control of the shop.

As we went over his costing system, an Excel-based model, it became clear in order to determine product cost, management was making a series of “best guesses”.

ProfitabilityThe company had a dozen cost centers each doing a different type of operation and each requiring different support both in labor and other expenses; such as, utilities, indirect labor, and quality. The actual usage of those resources were incurred disproportionately among the various cost centers. The owner realized the best method of operation was the development of rates per hour of production for each of the cost centers. This would then be applied to each of the parts based on the speed at which they crossed a given cost center.

The owner used his industry knowledge, past experience, and best guess to set the machine rates based on estimates without any specific identification or knowledge of what his operation may actually be incurring. Each of the dozen costing centers had costing rates assigned, but all without any regard to a method of allocating costs and actually computing rates.

The other component the owner had estimated was the speed at which the parts were being produced. Again, based on his industry knowledge and his relative understanding of how the parts were processed, he developed estimated rates of production which were applied against the estimated hourly cost to produce product cost. These product costs were then used to determine profitability of jobs, set selling prices, or be used for overall profitability of customer, process, part or sales person. Needless to say, the results were unpredictable at best, and in many cases, absolutely misleading related to the actual costs being incurred on the floor.

The owner recognized the inaccuracies and was anxious to get started on a new system where the costs incurred by each process could be specifically identified. This would allow for the various rates of production by each of the parts to be more carefully recorded and compared to early results. This comparison would ensure the costs would be as accurate as historical records and the actual cost per hour of each the cost centers would accurately and fully recover the cost associated with that center.

The owner envisioned a variety of sales and marketing tools resulting from knowing accurate product cost and how that could be used to help position the company with potential customers as a preferred supplier. His concern with the existing method was that some products were being costed far above what they actually cost and others were being costed far below. The end result, some jobs were awarded which would never result in profitable operations and in the other case, jobs were not even given consideration due to competitive quotes at far lower price.. We ended our conversation with an agreement to begin the process of identifying cost centers and production rates, so that we could begin the process of building a new, more efficient cost model. One that would also supply a variance analysis, which would help improve the efficiency of the entire manufacturing operation.

Categories: Cost Accounting

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